The Price is Right. Or Is It?

Over the past two years the rising cost of coffee (and almost everything else) has us asking: What is the right price for a cup? As a trade association we cannot and will not recommend a price for a cup or a pound, but we can explore how coffee retailers can and should arrive at their own pricing decisions.

First of all retailers should know that there is nothing new or groundbreaking about the paradigm for pricing—everything here has been said before. An article 20 years ago would have laid out the same fundamentals of pricing as it relates to business. But then again, 20 years ago most Americans had never had a cappuccino, most of us probably had more money in our 401K, the price of coffee was less than half of what it is today, and banks were still lending money. Which still leaves us with: What is a reasonable cost for a cup of coffee?

Before one can answer the basic pricing question, it’s necessary to establish a business plan, beginning with hard questions such as: Do customers want or need your product and will they be willing to pay for it? If so, how much will they pay and what is the competitive landscape like? Are there others who sell the same or a similar product? What competitive advantages can the business enjoy? How elastic is pricing and demand for this product? How large is the market and can it be expanded? How will the product be marketed effectively? All of these questions are worth answering before launching any business; The more entrepreneurs know about how their product will fit into the market, the better their chances of success.

Equally important for entrepreneurs is having a keen understanding of the costs associated with the business. What are the fixed overhead costs? What are the incremental costs? What are the finance costs? What are the costs of goods sold? What marketing costs are necessary to implement the marketing plan? Together with the market assessment this understanding of costs allows the business operator to undertake an informed pricing strategy.

Pricing strategies ultimately consider the objectives of the business. If the primary objective of the business is return on investment (ROI), the pricing strategy will differ from one where survival of the business is the primary objective. Pricing strategies are also dependent on the positioning of the product and the business. Low cost providers will obviously price much differently than the quality leader in the same market. Regardless of your business type or segment, in the end you set pricing through a process of calculating your costs, estimating your product’s marketability to consumers, and comparing your product and service quality to the prices of others that are similar. When sales are of sufficient quantity at a high enough margin to exceed all operating expenses and costs then the business is viable.

For any specialty coffee retailer there is no better time than now to review and challenge the assumptions made when the business first started. The operator can assess the market for her product and accurately determine how the business is positioned in the marketplace. Costs can be fully calculated, with an eye towards potential cost of goods versus actual cost of goods. A closer look at fixed overheads and incremental operating expenses such as labor is possible because one has real life experience and data.

The first step in reexamining the pricing model for the business is to address real costs. Chances are that at some point our operator used a list of prices for coffee, cups, condiments, etc. to determine a potential cost of goods for each menu item. A sophisticated operator may have factored in waste and spillage as part of this calculation. An ongoing retail operation should make a comparison between the potential cost of goods and the real cost of goods on a regular basis. This exercise not only reveals areas of waste or shrinkage, but it also provides the basis for a substantial piece of the pricing decision. If it is apparent that costs have risen significantly but prices and portions have remained unchanged then margins will have suffered and menu changes are necessary.

Similarly, examining historical operating expenses, including fixed overheads, previously estimated costs like repairs and maintenance, and marketing expenses gives a clear view of where existing pricing is meeting or falling short of revenue objectives. Finally, labor, particularly incremental labor, can be evaluated and factored into the updated business model.

Other valuable data that relates to the revenue picture, including sales mix, day part volume, average transaction value, and average number of transactions can be determined, and taken in concert with the costs considered above it is now possible for the operator to determine with accuracy the real prices and margins necessary for the business to succeed.

The final piece of the pricing equation is to consider the competitive landscape. What are nearby competitors charging for the same or similar products, and how are the values of those products perceived? Here it is helpful to undertake a price survey that is segmented by competitive position and determine if the market position of the business must be modified.

The outcome of all of this data gathering and assessment is a realistic picture of where the business is performing to expectations and where it is not. Decisions about pricing can then be made to influence business operations. For example, if potential costs of goods numbers are substantially lower than actual cost of goods, the operator can scrutinize recipes, portion sizes, condiment usage and sales procedures to look for areas in need of attention. It may be apparent that prices need to increase or portions be decreased to address the situation.

Similarly, the operator can reassess the positioning of the business in the local market. Are your products and services viewed by customers as being at the high end, the middle, or the low end of the local market? How do prices match up to these perceptions? One key indicator is the volume of repeat business. High numbers of repeat customers indicate that price and value are within the acceptable ratio and that customers are relatively satisfied. Low levels of repeat business are a good sign that the value proposition is failing and either quality of product needs to increase or the price is too high. It is critical that the operator gain a realistic perspective on market position and work to enhance value within her segment.

There’s an old New Yorker cartoon that shows a row of pizza sellers lined up right next to each other on a block in New York. Looking at them from left to right, you see the signs in their windows. The first one says in modestly sized letters: “Best Pizza in New York City!”; the second one blares: “Best Pizza in America!”; the third one proclaims: “Best Pizza in the World!”; the fourth one virtually shouts: “Best Pizza in the Universe!” At the fifth pizza joint, a humble little affair, we see the proprietor standing out front smiling at the long line of customers, and the sign in his window says: “Best Pizza on this Block.”

Specialty coffee retailers are uniquely positioned to compete in their markets for the Best on the Block status, but must provide a quality of experience, a quality of product and a quality of service that allow them to lay claim to that title. Balancing this customer experience with appropriate pricing may allow them to also be the most financially successful one.

Ric Rhinehart is the Executive Director of the Specialty Coffee Association of America. He has more than 20 years of experience in the specialty coffee industry and has designed, developed and produced a wide range of coffee and tea products. He has considerable experience in developing manufacturing and packaging capabilities, and has traveled extensively as a green coffee buyer.